Stubborn inflation, the Fed, bank failures, and the fear of more bank failures has ushered in a return of fear and stock market volatility. Is this anything to worry about or is it part of the bottoming process to a stock market uptrend that began in 2009? Nobody knows for sure, but if you’re actively participating in your employer’s retirement plan and/or contributing to your IRA, you’re taking advantage of the good that can come from a volatile market - buying more with fewer dollars.
However, as we age, many start to feel differently about money. We become more fearful and emotional and think much shorter term, even though life expectancy is ever increasing. We become ultra-protective with our money and seek to eliminate all risk of loss. When you consider that most will spend 25-30 years in retirement, this mindset may cause an equally poor outcome-running out of money. Whatever the reason for the fear and emotion, it’s real and we must understand and deal with it, or risk letting it influence poor decisions.
Let’s talk about what is causing the return of fear and volatility. Quite simply, there was too much money available for too many for too long. Deficit spending by the government, strong consumer spending, the ballooning of corporate and personal debt, and the rapid rise in real estate values fueled in large part by historically low interest rates all converged to create the “supply-chain” issues that made most everything we buy, from microchips to baby formula harder and harder to get. Supply and demand kicked in, prices rose and our dollars bought less (inflation) In mid-2022, inflation reached levels that we haven’t seen in nearly four decades.
Enter the Federal Reserve Bank of the United States. To fight inflation, they began pulling money out of the economy and began raising interest rates at a pace never seen before in history. The stock market wasn’t prepared for such a rapid increase in interest rates, and as a result, it started, and continues to reprice stocks with the expectation that the US economy will either slow it’s growth (soft landing) or shrink (recession). Fifteen months later, the markets are still trying to fairly value stocks and the volatility of 2022 has carried over into 2023.
As investors, we’ve reached a fork in the road. What should the average investor do? If you’re 20-40 years old (maybe in your 50’s), go back and reread the beginning of this article. If you’re nearing or in retirement, concerned or scared and not sure what to do or who to talk to, let me suggest an alternate path.
I recently read a great analogy that compares stock market volatility to taking a voyage across the ocean. Inevitably you will encounter a storm during your voyage. You have two choices; batten down the hatches and go directly through the storm and hope for the best. You will likely encounter damage that will set you back in your journey. How long of a setback depends on the severity of the storm.
Your second choice is to go around the storm. Temporarily altering your course will obviously extend your journey, and you may miss some good days, but the damage you sustain will likely be minimal. When the storm passes, you’ll get back on course and continue your journey.
Now some may ask how do you know how bad the storm will be and if you should go through or around it? Truth is, you don’t know, but weather patterns, radar, and past storms may shed some light on what to expect. The same is true for the stock market. There is a century of market history showing patterns, trends, challenges, and outcomes. As in life, if we don’t learn from history, we’re doomed to repeat it. Very few bear markets (a market that is down 20% or more from its most recent peak) are unique. They all share many characteristics and causes. It’s how we react to them that makes the biggest difference.
So how does an investor use stock market history to make decisions? Let’s start with a few basic foundational beliefs:
No strategy or process is guaranteed
There is no way to control stock market volatility
We must eliminate emotion from the decision-making process
As we get older, emotions play a larger role in many of the decisions we make, especially about relationships and money. Most individual investors aren’t capable of separating emotions and information on their own, they need a buffer. They need an unemotional third party with the knowledge, experience, and resources to replace emotion with data and information.
As we stated before, an investor can’t control stock market volatility. However, an investor can control their exposure to that volatility. If we see the storm coming, we can go through it (buy and hold) or go around it (defensive). I’m not talking about market timing. I am talking about paying attention to what the market and the economy are telling us. I’m talking about learning from past economic and market downturns to make data driven decisions.
I suggest working with an experienced advisor to build a low-cost, tax efficient investment portfolio that combines elements of buy and hold with tactical or defensive mechanisms built in. These unemotional, defensive mechanisms rely on analyzing data and establishing a set of rules to make investment decisions.
For most, a long-term investment portfolio should include an allocation of high-quality stocks for the growth potential to keep pace with inflation. I prefer stocks of companies that have a history of paying and growing their dividend. There should also be an allocation that can quickly exit the market if the data suggests that the risk of remaining invested becomes too great. Finally, there should be an allocation of bond investments. Bonds provide a reliable stream of income and, most of the time, an offset to the volatility of stocks.
I call this defensive style of investing Tactiful™ investing. The purpose of this strategy is not to avoid all drawdowns in the value of an investment portfolio. Remember our first foundational belief is that no strategy or process is guaranteed. What we are trying to avoid are the massive drawdowns that cause poor, emotional decisions at the wrong time. By taking emotion out of the equation and replacing it with data driven rules, we hope to build a portfolio that captures a majority of the upside of the stock market while limiting the downside.
It's important to remember that even if we go around a storm, we will run into some clouds, wind and rain. The same can be said of employing a tactical or defensive approach to the stock allocation of your investments… we will experience some volatility and drawdown. But hopefully, far less than if we went directly through the storm.
If I can answer questions about this approach, or if you would like to see if it’s right for you, please schedule a call.
About Sal D'Angelo
I am the founder and President of LakePointe Advisors LLC, a Northeast Ohio based financial solutions firm. I am a trusted advisor to entrepreneurs, physicians, and other healthcare professionals. I provide the experience and advice to help people build and protect their wealth, reduce their taxes, and build a secure future for themselves and those they care about.
I am a lifelong resident of Northeast Ohio. My wife and I are proud parents to three grown children. When not working, I enjoy sports, especially football and golf, and spending time with family and friends.
To learn more about LakePointe Advisors, connect with me on LinkedIn, like me on Facebook and follow me on Twitter.
For a comprehensive review of your personal situation, always consult with a tax or legal advisor. LakePointe Advisors does not provide legal or tax advice.
All investing involves risk, including the possible loss of principal. There is no assurance that any investment strategy will be successful.
Advisory services offered through Fourth Dimension Wealth LLC, a Registered Investment Advisor. LakePointe Advisors LLC and Fourth Dimension Wealth LLC are separate entities.
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